Max out 401k or use a Roth IRA?

[EngineerInCO]

I'm a new member here... 25 years-old been working 2 years full time since I graduated.

I'm saving $1000 each month and I don't know what to do with it. I have enough extra income to crank up my 401k contribution to 20% or 25%... I've also heard about using extra savings to max out a Roth IRA first. Here's my current status:

Income (pre-tax): 62,000
Checking acct: 18,000
401k: 20,000
Rent: 450
CC debt: 0
Car payment: 0 (just payed off a few months ago)

I'm spending what I want on travel and fun stuff, but I still end up with about $1000 extra every month. I'm not buying a house anytime soon, and my car is pretty new (40k miles).

I'm currently contributing 12% of my pre-tax income to the 401k. Which is already over what my employer matches (4%).

Based on my quick survey of options. A Roth IRA could be a good way to save more for retirement. Savings accounts look like they such a low interest rate.... However, maybe using a CD or a mutual fund for more of a short-term/medium-term savings vehicle (rather than just have it sit earning nothing...).

[GrimJack]

If your company offers it, you can do a Roth 401k along with your regular 401k (or you can change your allotment). If you decide to go with a Roth IRA, make your (2012 $5,000) contribution on Jan 1 so you get the whole year's use of the Roth benefits. Since you can contribute $11,500 to your 401k but not in a lump sum (er, is that correct? or can you contribute to your 401k in a lump at the start of the year?), there are some interesting options available to you with your income.

Remember, Romney somehow managed to park somewhere between $20 and 101 million in an IRA using those very limits.

[disneysteve]

Welcome to the site. Congrats for already being such a good saver and asking questions like this. It will serve you well down the road.

What are you total monthly living expenses? You listed rent but didn't list anything else.

A good minimum is 15% of gross for retirement. I would definitely do $5,000/year to a Roth before I would increase the 401k contribution. There are a few reasons for this which we could go into if you're interested.

Beyond that 15%, make sure you are setting aside money in non-retirement accounts for other financial goals. Maybe you aren't thinking about buying a house soon but saving up a 20% down payment takes time. Nothing wrong with starting now. On a 62K income, you could afford up to about a 180K home so that means accumulating at least 36K for a down payment. Plus money for moving and closing costs and furniture and more.

[Slug]

+1 to everything Steve said. Definitely get going on the Roth.

[BMEPhDinCO]

Great position to be in. My thoughts:

RothIRA #1 - with $1k per month, you can do this by the end of Dec for this year, and by the end of May for next year.

After next May, you'll start a budget for auto (registration, mechanical issues, next car, insurance, etc - I'd put in $100 for this, at least), a budget for housing (not just for a house, but also for rent, insurance on your stuff, etc - I'd put $150 for this, at least), a budget for life (ie dating, gifts, etc, the little things - $50 a month, at least), a budget for travel (going home, going around the country, going on trips to camp, ski, etc - I'd put $200 for this), and finally, I'd start investing the other $500 in the market - starting early would be a good idea and you can be more flexible with that money.

[EngineerInCO]

Can you elaborate on the Roth vs upping the 401k contribution?... What if I'm drawing no income in retirement -- wouldn't it be better to be paying taxes in a lower bracket? Is the idea that I draw from a Roth first (aka while I'm still working and earning income in a higher bracket than I am today)?

Also... my employer offers a Roth 401k in addition to the traditional 401k. They do not offer a Roth IRA. Is a Roth 401k going to meet my needs like the Roth IRA would?

My total monthly living expenses are about $2000 per month.

Welcome to the site. Congrats for already being such a good saver and asking questions like this. It will serve you well down the road.

What are you total monthly living expenses? You listed rent but didn't list anything else.

A good minimum is 15% of gross for retirement. I would definitely do $5,000/year to a Roth before I would increase the 401k contribution. There are a few reasons for this which we could go into if you're interested.

Beyond that 15%, make sure you are setting aside money in non-retirement accounts for other financial goals. Maybe you aren't thinking about buying a house soon but saving up a 20% down payment takes time. Nothing wrong with starting now. On a 62K income, you could afford up to about a 180K home so that means accumulating at least 36K for a down payment. Plus money for moving and closing costs and furniture and more.

[bjl584]

I personally contribute 10% to my 401K and max a Roth. I think it is a smart strategy to invest in both as you get both a pre tax and a post tax advantage.

[disneysteve]

Can you elaborate on the Roth vs upping the 401k contribution?

Roths have a number of advantages over 401k plans. First, you have virtually unlimited choices of where and how to invest your money. You are not limited to the choices offered by your employer.

Withdrawals are tax-free in retirement.

There is no minimum withdrawal requirement. If you don't need the money, you can leave it in the account growing tax-free for as long as you'd like.

You can continue to a Roth whether your employer offers a plan or not. You can even contribute to a Roth for your spouse even if they don't work.

I'm opposed to doing this except in truly catastrophic situations but you can withdraw your Roth contributions at any time without penalty if you really needed the money in an emergency.

[kv968]

Can you elaborate on the Roth vs upping the 401k contribution?... What if I'm drawing no income in retirement -- wouldn't it be better to be paying taxes in a lower bracket? Is the idea that I draw from a Roth first (aka while I'm still working and earning income in a higher bracket than I am today)?

You shouldn't be looking at withdrawing from your Roth while your working. That account if for when you stop working.

Then IMO you should, ideally, first draw money from your taxable accounts (i.e. 401k's, social security, pension, etc...) until those withdrawals will put in a higher tax bracket, say 25%. At that point you'd start withdrawaling from the Roth so that you don't actually reach that next bracket whatever it may be.

Also... my employer offers a Roth 401k in addition to the traditional 401k. They do not offer a Roth IRA. Is a Roth 401k going to meet my needs like the Roth IRA would?

Tax-wise, the Roth 401k would function just like a regular Roth IRA. The only exception would be if there was employer match. That would have to go into a regular 401k since you would have to pay taxes on that when it's withdrawn.

[feh]

Generally speaking (this is a gross simplification), the younger you are, the better it is to use taxed dollars (like a Roth) for retirement. Compound interest is a magical thing.

So, what I'd do in your shoes, since you're already getting the max match from your employer in the 401K:

1. max out Roth
2. max out 401K
3. open a taxable account

[fruitbowlk]

I don't see an EF. You could start one with the money from your checking account. You could also have accounts for vacation, holidays,wedding etc. Please take out loans to pay for there wedding ring, wedding etc you could be savng for that now while you can and won't have to be stress when the time comes even though you aren't going to buy a house anytime soon you should start saving for one now and let it sit until you are ready. Think long term not only short term. What are some of the things you want and desire in life save for it now.

[EngineerInCO]

Now I need to change my question: Roth IRA or Roth 401k?

The R 401k through my employer has fewer options. The R IRA only let's me contribute $5000 a year.

[jpg7n16]

Do some combination of the two.

Roth IRA: $5k
401k (regular): 7%+

You'll get some tax advantage today, and hedge against the taxes of tomorrow.


I'm assuming you're single and probably live in a state with state income tax. The only thing I would switch would be if you're married and that's your combined income. Then do Roth 401k because of the low tax bracket today.

[Bad Saver]

Roth -

Little late to the discussion. Throwing in my public accounting experience. Board won't let me link...

Google article: The Tax on Your Retirement Savings, by Joe Cobb.

Problem is in the OTHER INCOME classification and taxation - when drawing a combination of social security & 401K/IRA savings.

[snafu]

Good on you for being young and aware of the need to plan your financial future. Moving the discussion further... What did you choose for employer's 401K? Savings a/cs in this low interest environment isn't keeping up with inflation. The expenses associated with CDs and Bonds can easily lead to negative returns at present. I wonder what level of risk you would be willing to tolerate. As a 25 y/o, you have a l-o-n-g time to ride out the roller coaster ride of the Equity market. Your investment portfolio will advance and be moved around over the long term.